Friday, November 22, 2013 - Big Round Numbers

Big Round Numbers

by Sinclair Noe

DOW + 54 = 16,064
SPX + 8 = 1804
NAS + 22 = 3991
10 YR YLD - .04 = 7.74%
OIL - .60 = 94.84
GOLD + 1.30 = 1244.70
SILV - .16 = 19.93

Record highs for the Dow Industrials and the S&P 500; we also have Dow Transports confirming the movement of the industrials, and small caps, as represented by the Russell 2000 are looking strong, pricey but strong. This was the 41^st record high close for the Dow Industrials this year.

The S&P 500 is above 1800 and that round number now becomes support. The 1800 level is 17% above the record highs from the Spring of 2000. So, if you just followed the buy and hold, you made 17% over 13 ½ years; which is lousy; and even worse if you dig into the numbers. Adjusted for inflation, the 1800 level is 14% lower than the highs of 2000. Then you should also consider the S&P 500 is a capitalization weighted index, meaning the bigger companies have a bigger impact on the index. Back in 2000 there were 25 companies that accounted for 45% of the value of the 500 stock index; so, really back then it was more like a 25 stock index, and a 475 stock index.

And really, the S&P is a dynamic index; meaning, the companies change. Back in the day, the high flyers were Lucent, MCI Worldcom, AIG, Sun Micro, Dell. This year, we're seeing about 450 of the 500 stocks in the S&P are up; that is a broad based rally.

The Dow closes the week up; the seventh straight week of gains; the longest weekly winning streak since the 8 week rally of December 2010 to January 2011. The S&P finishes a seven-week winning run. Investors are pouring more money into US stock mutual funds than they have in 13 years. Morningstar reports stock funds took in $172 billion in the year’s first 10 months, the largest amount since they got $272 billion in all of 2000. Even with most of the cash going to international funds, domestic equity deposits are the highest since 2004. The move marks a reversal from the four years through 2012, when investors put $1 trillion into fixed income as the financial crisis drove many to redeem from stocks. Losses this year in bond portfolios, combined with 25% gains in the S&P, and suddenly everybody is pouring back into stocks. This is called performance chasing, and it is risky business.

Market investors now have about 57% of assets allocated to equities. We've seen high equity valuations before, in 1999, and in 2006-2007. Sentiment among individual investors grew increasingly positive as the S&P 500 set new highs. Bullishness in the American Association of Individual Investors’ weekly survey has averaged 43 percent this quarter, up from 29 percent in August and a long-term average of 39 percent.

Now normally, that kind of bullish optimism would be a contrarian indicator. But that doesn't always mean we're headed for a drop.  In ICI data going back to 1984, annual mutual-fund flows turned positive twice before: in 1989, preceding market gains in eight of the next 10 years, and in 2003, when the S&P kept rallying until October 2007.

And don't forget that December is a historically good month for stocks. With average returns around 1.4%, compared to 0.5% for all other months. June and July have even better average returns than December does. When ranked according to average returns, December is in third place.

Furthermore, there is not much consistency to December's return from year to year. In fact, December on average was one of the worst performing months during several of the decades in the early part of the last century.

Bottom line: stay alert and let the market tell you what it is doing.

The stock market reached several very important big round numbers this week and experts suggested that reaching these round numbers could mean that the stock market will reach other, larger round numbers in the near future. Maybe. Maybe not.

These same experts suggest you ignore the fact that these round numbers have almost no meaning for your own particular individual life and keep your focus on the round numbers themselves, because they are round, and also larger than previous round numbers the market has reached.

Why is this happening, you might be asking, if you are one of the 62% of Americans who think the economy is getting worse. It is partly due to the Federal Reserve pumping cash directly into markets to keep the economy from teetering back into a recession. It is also partly due to the fact that President Obama has been the least effective socialist dictator in history, overseeing record highs in corporate profits while wages stagnate, widening income inequality, in what has been an extremely uneven recovery. 

And most of the gain in stocks seems to go right back to Federal Reserve policy. This week we had Bernanke saying the U.S. economy is getting better and, as per incoming data, the Fed will at some point slowly start to pull back support. But for right now, they aren't pulling back support because the economy is still too weak to stand on its own two feet. And you've got the OECD doing what all forecasters do these days: marking down their estimates for future growth and warning of various headwinds.

Meanwhile, mixed in with all this near-term analysis, many in my world are mulling over Larry Summers' warning that whatever the cycle is doing, the underlying problem is one of structural slog.

Barring new fiscal break-downs, like the failure to come to some kind of an agreement on the budget that expires mid-January, there will be less fiscal drag in 2014 than this year, and that should add to growth.* But don't mistake less fiscal headwinds for tailwinds. The optimistic view is that lousy, austere fiscal policy is sucking about 1.5 points off of real growth this year and will take 0.5 of a point off of next year's growth.

The fact that less growth is reaching the broad middle class and lower wage workers is a constraint on consumption, which remains 70% of the US economy. During the housing bubble years, (dangerously) cheap credit and the wealth effect from inflated home prices offset this drag, but that's behind us. Looking at inflation and average compensation, we see that there is no pressure from wages or prices on inflation and real compensation growth is flat, flat-lining in fact.

Meanwhile, we know that the economy's been growing and that company profits have been high. There's nothing wrong with profits, but there's definitely something wrong when they fail to lead to employment and earnings gains for the broad majority. 

Uneven consumer spending along with fiscal drag/austerity and political dysfunction have contributed to a weaker investment climate, not just in the US but in most economies. You keep hearing about "trillions on the sidelines." Again -- that's also a symptom of high profitability amidst weak demand, along with low inflation. Investors just don't see enough domestic projects with high enough prospective returns to get them back in the biz of investing in structures, equipment, software, at least not at rates that would give us the growth pop we need.

Of course, this begs for a strategy of investment in public goods, but that runs into the austerity buzzsaw. And besides, who needs infrastructure when you can just chase performance up to the next big round numbers in the stock market. We just might get there, or not.